Internet Stocks Scale Heights, Giving Some Experts Vertigo

Securities: Popularity of even money-losing firms keeps analysts debating whether investors are being foolish or prescient.

SAN FRANCISCO — Shares of Internet-based companies continued their gravity-defying ascent last week--even while most tech stocks were slumping--prompting a new round of questions about whether online firms' financial performance will ever live up to Wall Street's stratospheric expectations.

Amazon.com, Yahoo Inc., EarthLink Network Inc. and half a dozen other Internet firms watched their stocks climb to record highs, even though they started the week at altitudes that leave investors in other industries gasping for air.

Amazon.com, for instance, finished the week with a market capitalization--stock price multiplied by the number of shares outstanding--approaching $1.9 billion, despite the fact that the online bookseller has never had a profit and posted sales of just $148 million last year.

In contrast, rival Barnes & Noble Inc.'s market value is in the same ballpark at $2.6 billion, even though it, too, has an online business, not to mention 1,006 stores and $2.7 billion in sales--18 times Amazon's.

Analysts said they have never seen a group of companies whose stock values are so out of proportion to historical financial performance. But they added that when it comes to the Internet, conventional means of evaluating stocks no longer apply.

Paul Noglows, an analyst at the investment bank Hambrecht & Quist in San Francisco, called the valuations of many Internet stocks "heady," but added that it's tough to say what levels are reasonable, given expectations for the growth of the Net itself.

According to researcher International Data Corp., the number of Internet users worldwide was 68 million at the end of 1997 but is expected to grow to 97 million by the end of this year, with no end in sight.

"The Internet opportunity as a whole has not been overvalued," Noglows said. "And those companies that play a defining role will justify over the long term the premiums being put on them today."

There were a few rational explanations for the Internet stocks' spike last week, including President Clinton's recent pledge to keep the Internet free of taxes.

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Investors also seemed to be shifting their bets to Internet stocks and away from traditional computer powerhouses, including Intel Corp., Compaq Computer Corp. and others that recently warned of sinking profits. As their shares stumbled, Net stocks climbed.

In fact, the rotation hinged on the theory that Internet companies might actually gain from a price war besetting their PC brethren. As computer prices plunge, the theory goes, more people will buy them, link up to the Net and turn to companies such as Yahoo, Amazon and EarthLink for goods and services.

But these recent developments merely added altitude to stocks that were already sky-high. For some perspective, consider that bellwether stocks such as Intel commonly trade at prices 20 to 30 times their earnings per share. Even before Yahoo shares peaked at $92.38 on Tuesday, they had been trading at about 170 times earnings.

"From the day we started, I've told all our employees and managers not to pay attention to the stock price," said Tim Koogle, chief executive of the Santa Clara, Calif.-based search engine company. "I've told them to build a business that's good, big and profitable."

In achieving all three, Yahoo is a rarity among Internet companies. It posted a slim profit of $2.5 million last year (excluding the cost of buying e-mail service Four 11) on sales of $67 million.

But at this stage of the Internet's development, Koogle is less concerned with profit than with positioning Yahoo as consumers' favorite starting point on the World Wide Web. By pursuing a strategy of gathering as much content as possible and presenting it in the simplest fashion, Yahoo has broken away from the Net navigation pack.

Yahoo was visited by nearly 40% of all Internet users in January, double its closest competitor, according to research firm Media Metrix. That helps explain why it also collects more ad revenue than any other site and is increasingly getting a percentage of its advertisers' transactions. Web advertising is expected to grow from roughly $940 million last year to $7.67 billion by 2002, according to researcher Jupiter Communications.

Analysts say there's no such thing as a sure thing on the Internet, but Yahoo comes closer than most. Others' positions are more precarious.

Seattle-based Amazon, for instance, is by far the leading bookseller online, with between 65% and 80% of the market, according to various estimates. But the looming presence of Barnes & Noble, which can afford to treat online sales as a loss leader, makes Amazon appear vulnerable.

EarthLink, the Pasadena-based Internet service provider, has rapidly built its subscriber base to 650,000 with a deft consumer touch and a recent deal to absorb Sprint Corp.'s subscribers.